“If you can keep your head when all about you are losing theirs…”Rudyard Kipling, from the poem “If”
We are being asked by some clients if we’re in a correction in 2022 or if it’s a bear market. As of the time of this writing, the S&P 500 (GSPC) is off about 13% from its high of just over 4,800 on January 4, the Dow Jones Industrial Average (DJIA) is off about 10%, and the NASDAQ 100 Index ( IXIC) is lower by approximately 22% YTD.1 With those returns, it is not surprising that investors are concerned. For the record, a correction is a selloff in one of the major indices of more than 10%. A bear market is defined as a selloff of more than 20% that is sustained for a period of time (in other words, a transitory breach of the 20% level does not constitute a bear market). So, as of the time of this writing, it could be said that we are in a correction, but we have not yet entered bear market territory.
Will a recovery start from current levels or will markets continue to languish? We don’t make short-term market predictions but we can say that the likelihood is that the bad times will be behind us before we reckon they should.
Reminder… The economy is not the market and the market is not the economy
But often it’s apparent that people think that bad times will last indefinitely and make projections and investment decisions based on that belief. Looking at financial headlines during a difficult market can lead to this kind of thinking. Bad news seems to get reported more often than good. That said, for investors it’s vitally important to remember that markets are in the business of discounting the future, not the present. Consequently, market recoveries often begin while coincident indicators such as Gross Domestic Product and lagging indicators such as the unemployment rate and corporate profits are still showing dismal results.
Fear, need for control, and the activity bias
Some investors seem to think that market declines should be accompanied by increased trading activity, suggesting that volatility has changed their risk tolerance and investment approach. Whether this is a garden variety correction, bear market or a bout of interim volatility isn’t worthy of much debate – asset prices are down. It’s been said that often we cannot control the things that happen, we can only control how we react to them. Market volatility happens. What is important is how we as investors react to it and what decisions we make for the future.
When uncertainty meets fear, people often attempt to use activity to regain a feeling of control. In investing, this is often an illusory exercise. The analogy I would offer is that selling out of a portfolio of fundamentally good investments because of a period of negative volatility is like a gardener digging up their flowers and trying to sell them because of a thunderstorm. We may think we are protecting our assets, but we’re only messing up our garden. The reality is that asset prices go up and they go down. As an investor, this is one of the certainties of the markets we must acknowledge.
Time in the market vs. market timing
Some investors believe that selling out when economic conditions begin to deteriorate and buying back in when they improve may be the answer. There are any number of issues with this line of thought, but we’ll only get into a couple here.
First, the idea of market timing assumes that the individual has insight or information that the rest of the market does not. As for the former, we would suggest that in this age of big data, sophisticated statistical analysis, trading algorithms and quantitative strategies, it’s quite unlikely that any individual investor is able to consistently outsmart the market with their own unique insights. As for trading on information that the rest of the market doesn’t have, in the age of Regulation FD, that’s just illegal.
Perceptions, biases, and emotions may all get in the way of many investors’ ability to make accurate timing decisions. In addition, a careful study of the charts of major market indices indicates that oftentimes the largest moves to the upside are seen in the wake of large declines. For too many individuals, timing out of an investment after a large decline results in missing the subsequent recovery, and returning to their allocation too late to recover lost value. The adage “Time in the market beats timing the market” is often true, largely because of this phenomenon.
The spring of 2020 provided any number of anecdotal examples of how investors can get whipsawed by fear and market volatility. A look at any chart of the S&P 500 will show that the market selloff related to the COVID-19 pandemic started in late February of 2020 and culminated with a low in the S&P on March 23rd. In late March, fear of what the pandemic meant for the economy was rampant. We, at Atlas, were fielding calls from concerned investors, and as always, we were urging our clients to remain calm and to stay invested according to their personal investment allocation. While at that moment, many would have preferred to sell out and go to cash until things “look better,” we continued our counseling efforts.
The next few days saw strong upward moves in the index and by mid-August, the S&P 500 had regained all its losses from the late February/March selloff. We would argue that economic predictions and earnings projections did not improve much in that period. But in hindsight, we can see that astute market participants were looking through the current challenges and investing in a recovery despite the dreadful headlines.
Buy low, don’t sell low
Conversely, the bursting of the tech bubble in the early 2000s is an example of how investing when things appear wonderful can be a recipe for disaster. At the time, many thought we were in a “new era” of investing, using technology stocks as a vehicle to all things modern. Investors were applying what seemed to be astronomical valuations to companies that were barely, or not, making money. The fear of missing out seemed to drive investors’ decision-making. But, as experience has shown repeatedly, valuations and profitability matter in the long run. Those that chased stocks while the economy was booming were sorely disappointed as the NASDAQ 100 went through several terrible years after March of 2000. (Ironically, a book using the term “New Era Value Investing” was released just after the tech bubble was deflated).
The academic research on market timing is compelling. Investment industry journals provide studies on the topic somewhat regularly. For those that do not have access to professional journals, one only needs to go into a search engine and enter the term “Market Timing Fallacy” to get a feel for what is written for public consumption.
If you can keep your head when all about you are losing theirs…
What the research does tell us to do is straightforward. The advice is to ignore interim volatility and stay invested in accordance with your individual risk-based asset allocation, and don’t let market volatility change your risk tolerance. The difficulty is in keeping your head and maintaining your risk tolerance through the volatility. This is where a strong relationship with your Atlas Wealth Management Advisor comes in. We believe that maintaining an eye on the horizon, while not getting too wrapped up in the day’s headlines is a big part of the solution. We believe in the capitalist system and its ability to be leveraged to build wealth. As such, we should look for opportunities to invest at attractive valuations. Ironically, those valuations are most often available when things look bleak. So, just like the investors who in the spring of 2020 were looking ahead with optimism, we need to learn to withstand volatility to achieve long term success.
1 Morningstar and Refinitiv 6/8/22